August 31st, 2020 by Frugal Moogal
If you’ve been following the stock price lately, you might be forgiven if you think Tesla has had a huge cresting of news lately. In fact, on the day my previous article was published, Tesla stock closed at $1500.84. Today, as I write this, the stock price is currently at $2,213.40 per share, right before the split occurs.
While I suppose it could be argued, I feel like the biggest news affecting the price of the stock between those two dates is the upcoming stock split that will be completed Monday, August 31, and that’s what I want to dive into here. Stock splits shouldn’t matter, but I think the market is getting this one right, because Tesla presents a unique situation. So, let’s dive in!
Why Stock Splits Shouldn’t Matter
Before understanding the difference between Tesla and regular stock splits, let’s make sure we are all on the same page about what a stock split does.
A stock split is exactly what it says it is — the company takes a share and splits that into a predetermined number of shares, which are all worth 1/X of the value of the original share (with X being the number of shares they are split into).
Stocks can also reverse split, where a company will combine multiple shares into one, with the new share price being equal to the price of the shares that were combined. Groupon is an example of a company that did this recently, performing a reverse split of 1-for-20, meaning that if you had owned one share — as I happen to, thanks to opening a Robinhood account — you (or I) now own 1/20th of a share.
When these splits occur, nothing else really changes. The value of the company remains the same. Now you just have more shares, or in the case of a reverse split, fewer shares, that combine for the same total amount of cash value. Earnings per share calculations change based on the new amounts, and can be confusing when you are looking at older articles about profit that don’t automatically update, but a stock split doesn’t change any fundamentals about the company. For instance, as before the split, Tesla will still have over $500 million of warranty repair reserves that it could immediately recognize as revenue.
The point is that stock splits really don’t change anything.
I feel it’s also worth pointing out that stock splits are often done by companies that have been gaining in value, while reverse splits tend to occur with companies that are in trouble. Reverse stock splits can be used to try to keep their shares listed on exchanges that have minimum share price rules, as that is important for getting equity investors to actually purchase them. A cynical person could say it also tricks investors into thinking the company has had a boost. I was sort of excited to discover the stock tracker program I use suddenly showed my single share of Groupon way up, and I was wondering what happened. Maybe I should start caring about it.
But standard stock splits have mostly fallen out of favor. The main reason for them is to to make shares seem more affordable to small investors. Today, with a number of the brokerages that target small investors, like Robinhood, offering the ability to purchase fractional shares — or the ability to buy as little as 1/1,000,000th of a share — a number of places have argued that stock splits weren’t interesting any more, and they were mostly for investors to see share prices soaring into the stratosphere.
The market response to Tesla’s announcement has blown a bit of a hole in that argument, and I think there is a really good reason for it.
What’s The Benefit?
While stock splits don’t affect overall company valuation, earnings, losses, or anything else, there is one thing that they do impact — and that’s the ability to vote your shares. Many of the companies that offer fractional shares do not allow fractional shareholders to vote their shares. Robinhood is one of the few that I could find that does allow you to vote, and collates those votes.
In the case of most companies, the ability to vote your shares probably isn’t a big deal. Institutional investors and “retail” investors often see Tesla in wildly different ways. Many of us who started diving into Tesla expected to find some positive and negative information. Last October, I wrote an article about why I originally made a small, 8 share investment into Tesla — I felt that it was a risky stock but one that had potential to increase astronomically in the future. That date in October, I identified 11 points where I saw Tesla doing significantly better than most analyses were showing, and as I’ve continued my own analyses, I couldn’t find evidence where I didn’t believe that the company would execute and grow quickly.
While it seems like Wall Street analysts are starting to understand the bull thesis on Tesla — although, I think a lot of them upgrading their price targets is due to herding (worth a future article of it’s own sometime) — you can still find incredibly silly arguments regularly pushed and promoted. There are still many analysts pushing the argument that Tesla is just a car company. There are still articles written claiming that demand doesn’t exist.
If you’ve dug for your own evidence, those arguments fall apart with actual research. Most of the articles I’ve written are me looking at bear theses to see if they’re valid. With companies I invest in, the bears often have decent points. Tesla is the one company I’ve ever held that I haven’t found a single bear argument with which I agree.
This has everything to do with the stock. Shareholders can force companies to allow shareholders to vote on resolutions that can force companies to change the direction of the company or how it’s managed. Carl Icahn and Dan Loeb are two investors known for that.
It isn’t unrealistic to think that Tesla could have an activist shareholder force a vote on something that might drastically change the direction of the company. In the past earnings call, Elon Musk said, “What bugs me the most right now is that our cars are not affordable enough.” Imagine if an activist investor forced Tesla to hold a proxy vote on if the company should reduce the price of its vehicles or make more money. It isn’t hard to envision a world in which the institutions who own the stock but don’t seem to understand it decide to vote for profits over price.
While I think that Tesla would easily survive such a vote — after all, Elon Musk owns around 20% of the outstanding Tesla shares — the more retail investors have access to voting shares, the more likely the company is to be insulated from changes those Wall Street types may think would make the company better.
I was ecstatic when I heard that Tesla would be splitting its shares, for exactly this reason. With how far off Wall Street investors have been about Tesla so far, I feel any potential reduction in the influence of institutional investors who may be swayed by an activist who attempts to have a proxy vote to change the company is a good thing.
While there are no hard numbers out there, it’s believed around 75% of Tesla is owned by institutional investors and Tesla executives. If retail investors make up the missing 25%, ensuring as many of those investors as possible can vote means that, when combined with Tesla executives, the company should be able to continue to execute it’s strategy exactly how it best sees fit, without outside interference.
And that, to me, is worth a premium.
I am a Tesla [NASDAQ:TSLA] shareholder who has purchased shares within the preceding 12 months. Research I do for articles, including this article, may compel me to increase or decrease stock positions. However, I will not do so within 48 hours after any article is published in which I discuss matters that I feel may materially affect stock price. I do not believe that my voice could or should influence stock price by itself, and I strongly caution anyone against using my work as your sole data point to choose to invest or divest in any company. My articles are my opinion, which was formulated using research based on publicly available data. However, my research or conclusions may be incorrect.
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